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A new Gilded Age ahead: Thomas Piketty's 'Capital in the Twenty-First Century'

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Book jacket of Capital in the Twenty-First Century

Capital in the Twenty-First Century by Thomas Piketty is the economics publishing sensation of our times, especially in the United States. Currently the No. 1 seller on the U.S. Amazon website and widely debated in the "blogosphere," this long book is being favourably compared to the seminal works of Adam Smith, David Ricardo and Karl Marx, which placed the distribution of income and wealth at the very centre of economic inquiry.

As an aside, there seems to have been remarkably little discussion and debate of the book in Canada to date. It does not yet appear on the Globe and Mail bestseller list and has received few reviews.

Karl Marx famously thought that capitalism would lead to the concentrated accumulation of the means of production in fewer and fewer hands, leading to a collapse in profitability and socialist revolution led by an impoverished working class. (As Piketty notes, he lacked good data, and wrote as capital was indeed rapidly accumulating and mainly before rising productivity fed through to rising wages.)

Piketty is no Marxist, but he does think that are very strong tendencies for capitalism to lead to the extreme concentration of financial wealth in the hands of a small oligarchic elite if democratic political forces do not push back and implement policies to promote shared prosperity. He places particular emphasis upon the need for progressive taxation of income and, especially, wealth, and calls for an internationally co-ordinated progressive tax on accumulated wealth.

Piketty's big fear is that we are on our way back to the Gilded Age society of the late 19th century in Europe and North America in which the top 1 per cent owned about half of all wealth, and could live very comfortably off inheritances which produced annual incomes equivalent to about 30 times the average wage. This was the world of the idle rich "rentier" who lived off an inherited fortune. He warns that if we allow wealth to become concentrated in very few hands, the past will again "devour the future."

Piketty and various colleagues have transformed our understanding of inequality over the past decade or so by assembling detailed historical data on the distribution of income and wealth, and this book greatly adds to our empirical knowledge, especially of the ultra rich. It also makes a novel contribution by showing that the "capital-to-income ratio" -- the level of the total stock of capital or wealth compared to annual income measured by GDP -- has varied over time. This in turn has enormously important consequences.

The book defines capital as wealth, in the sense of assets which can be sold on a market, meaning land, housing and the privately owned means of production as represented by shares, bonds and similar financial assets. By this measure, the stock of wealth can vary in size relative to the annual flow of national income, and generally fell from a high point before the First World War to a low point after the Second World War, but has been rising in a U-turn since the 1970s.

Rising inequality

Piketty's central argument is that, if the capital-to-income ratio is high, and if the rate of return on capital is greater than the rate of economic growth, then inequality will inexorably rise unless offset by political forces. He thinks this will likely happen over the next few decades since global growth is slowing down due to demographic factors, since the rate of return on capital is normally greater than the rate of economic growth, and since the political forces that used to counter inequality have grown much weaker.

It is important to underline that Piketty is very cautious in advancing this central argument, and alert to the fact that contingent economic and political forces are always at play. He thinks that the decline in the capital-to-income ratio for much of the 20th century and a shift towards greater equality in the distribution of income and wealth was due to two world wars, the Great Depression, and hyper inflation episodes which destroyed large concentrations of wealth, as well as social democratic policies of redistribution which were in place from the 1940s through the 1970s. He offers us more of a warning than a firm prediction, but it is a warning that should inspire great concern.

Piketty demonstrates through meticulously harnessed historical data that the capital-to-income ratio has indeed risen since the 1970s, even though it was generally assumed by economists to be more or less constant. In the case of Canada, the stock of wealth has increased from two times GDP to four times GDP since the early 1970s, though this ratio is quite low compared to the United States and, even more so, compared to most European countries.

Capital vs. labour share of income

One key factor behind the rising stock of wealth has been high rates of return to capital compared to labour since the 1970s as wages have risen more slowly than strong corporate profits. As a result, retained corporate savings have increased, and stock prices have tended to increase at an even faster pace than earnings. The capital share of income has also increased because technological progress has continued to boost productivity even in a period of slow growth, and because labour has lost bargaining power due to cuts to minimum wages, the decline of unions, and the shift or production and investment to lower-wage countries.

Piketty does not argue that the rate of return on capital must always exceed the rate of economic growth. But he does argue that this is very likely to happen as growth slows, especially if new capital investment continues to boost productivity.

Having made a strong economic case that returns to capital are likely to exceed growth moving forward, Piketty shows that wealth is always much more unequally distributed than income, and has begun to become much more unequal compared to the levels of the mid-20th century.

Strikingly, he contrasts the Gilded Age to what he calls the patrimonial capitalism of the mid-20th century when a significant middle class first emerged. While the bottom 50 per cent have always had very little net wealth (about 10 per cent of the total), the middle class -- defined as the 40 per cent between the bottom 50 per cent and the top 10 per cent -- had some 40 per cent of all wealth at mid-century compared to just 5 per cent in the Gilded Age. The top 1 per cent share fell from 50 per cent in the Gilded Age to as low as 20 per cent to 25 per cent at mid-century before beginning a new ascent.

Piketty further shows that in European countries (data are very limited for North America) inheritance makes up a large share of wealth. In France, some two-thirds of all net wealth is now inherited, well up from the low point at mid-century. And very large stocks of wealth are accumulating at the very top in the hands of the top 1 per cent and the top 0.1 per cent. The limited evidence we have shows that the world's super rich are rapidly increasing their share of wealth and that a significant part of this concentrated wealth consists of inherited family fortunes.

The picture is somewhat different in the United States and Canada, where the stock of wealth compared to GDP is lower than in Europe, and inherited wealth is likely less important. But, the warning is that as income inequality mounts and more and more income goes to the top 1 per cent, this will spill over into much greater wealth inequality. Today's top 1 per cent in North America are often "super managers" who earn their income, rather than clip coupons, but their children will inherit large fortunes and become tomorrow's idle rich.

A challenge to textbook economics

Piketty has mounted a huge challenge to conventional neo-classical economics which holds that returns to capital reflect productive contributions determined by the marginal productivity of new capital investment. He could have made a sharper distinction between wealth and capital as a productive factor, and could have mounted more of a frontal attack on textbook economics regarding the determinants of the rate of profit and income shares as argued by Jamie Galbraith and Tom Palley among others. However, Piketty shows that political institutions and processes are central to the distribution of income and wealth, attributes the rising income share of the top 1 per cent in North America in part to the power of corporate insiders, and holds that there is something of an inherent dynamic to greater inequality of income and wealth under capitalism.

Some progressive economists have criticized Piketty for being insufficiently critical of capitalism as a system, and he indeed maintains that broadly shared prosperity is possible on the basis of predominantly private ownership of the means of production if democracy effectively counters the forces pushing for greater wealth and income inequality.

Piketty's policy prescription is for an internationally co-ordinated progressive global tax on wealth to deliberately limit the growth of very large fortunes. While considered utopian by many critics, he does show that at mid-century the U.S. and the U.K. in particular levied steeply progressive and indeed punitive personal income taxes and estate taxes to deliberately counter the extreme concentration of wealth. He also shows that there was a large shift towards greater equality in the 30 years of post-war social democracy due in part to progressive policy choices.

Piketty has also been criticized, with greater justification, for stressing the need for progressive taxation and generally ignoring other redistributive mechanisms such as higher minimum wages, stronger unions, closer controls on excessive pay and profits, and closer regulation of the financial sector. He touches on these other mechanisms which would help equalize pre-tax incomes only in passing and has too little to say about how broadly shared prosperity at mid-century was based upon a strong labour movement, limited international investment flows, and a closely regulated financial sector.

But these issues for discussion by progressive economists do not detract from a huge achievement. 

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